Finance

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

The bad-debt clouds have parted, and a ray of profit is shining through. Investors in Indian banks, forced to live with quarter after quarter of wealth destruction, are basking in the warmth of a 45 percent rally in the country's Bankex Index over the past seven months.

They should enjoy their day in the sun. In a few years, the air will turn nippy again as the Paris agreement on climate change leads to global norms that force lenders to hold more equity against loans to polluting industries.

If that prognosis comes to pass, the capital-starved Indian banking system, which has an exposure of almost $200 billion to power, steel, chemicals, energy and mining, may face a fund-raising challenge not yet on investors' radars.

Risk Is in the Air
Indian banks' capital deficit could worsen if they have to provision more for loans to polluting industries
Source: RBI

If anything, banks' exposure may be six times higher. According to a Trucost study, Indian lenders are financing businesses with a "natural capital" cost of 90.5 trillion rupees ($1.4 trillion).

There's no formal accounting for exploiting nature's bounty. Costs get passed on to current and future generations as noxious air, polluted water and degraded soil. Agriculture and industry might be forced by government taxes and penalties to internalize this cost. Or at least that's what must happen for India to meet the climate-change obligations it adopted this week. Once such a framework is in place, borrowers' repayment ability may be significantly affected.

Lenders must be mindful that discussions, globally, are "veering towards penalizing industries which add to carbon emissions, and banks may be forced to hold additional capital for loans to such industries on account of increased risk weights," S.S. Mundra, a deputy governor at the Reserve Bank of India, said in a speech last month.  

But why stop at carbon?

Take, for instance, the connection between water and banking. India got a lucky break in 2016 with the best-distributed rainfall in three years, according to local ratings company Crisil. But as Gadfly noted, the nation's water worries are just beginning. Earlier this year, state-run NTPC, India's largest power producer, was forced to shut its Farakka thermal plant in eastern India because of water shortages. Still, New Delhi plans to add 40 percent to thermal-power capacity by 2022.

Here Comes the Sun
Bad-loan-plagued Indian banks have outperformed the benchmark equity index this year
Source: Bloomberg

Apart from emitting greenhouse gases, coal-fired power plants also guzzle water, competing with agriculture, the biggest user. Since the government's policy is to coax lenders to make farm loans, banks are particularly at risk from failed harvests, especially in rain-dependent crops such as wheat and cotton.

The Trucost study used Yes Bank's March 2015 advances figure to estimate that for every rupee lent out, borrowers have used up more than three rupees in natural capital. As soon as there are Basel-type rules on how banks need to manage their environmental risk, lenders will have a whole new capital hole to worry about. And that's on top of an $18 billion deficit Moody's estimates 11 state-controlled lenders face over the next three years.

Food for Thought
Estimate of "natural capital costs" financed by Yes Bank under various scenarios of farm loans to total loans
Source: Trucost report, titled "Natural Capital Risk Exposure of the Financial Sector in India," October 2015

According to Carbon Tracker, India needs to forswear 27 percent of its planned capital expenditure on coal mines by 2025 for the world to meet its goal of limiting the rise in average temperatures to 2 degrees Celsius above pre-industrial levels. Given mining monopoly Coal India has massive financial resources, the only way to curb excessive investment is for thermal power plants to become expensive to finance.

The rain on Indian banks' parade may not be all bad news after all.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Natural capital refers to the world's stocks of natural assets, including geology, soil, air, water and all living things.

  2. India has committed that by 2030, non-fossil fuels will account for at least two-fifths of electricity generation. De-emphasizing coal, however, will need some form of carbon taxation.

To contact the author of this story:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net